Interview

Milano, 3 giugno 2016 - 21:26

El-Erian: the Fed will decide a rate hike after the Brexit referendum

If it weren’t for the uncertainty associated with the Brexit referendum, a June rate hike would be appropriate. But it is highly likely in July. The ECB’s action? Without the support of other policies, its influence will remain modest; and it is not without risk»

di Giuliana Ferraino

« If it weren’t for the uncertainty associated with the June 23rd Brexit referendum, a June rate hike by the Fed would be appropriate. Why? Because the labor market has continued to improve, creating jobs and reducing slack; inflation and wages are finally edging up; and Fed officials are increasingly aware of the collateral damage and unintended consequences of artificially low interest rates. If the Fed does not hike in June, it is highly likely to hike in July and, in my opinion, definitely by the September Fed policy meeting», says Mohamed El-Erian, 57 years old, chief economic advisor of German Insurance Allianz and former Ceo of Pimco.

Another Fed’s hike should prove that the US economy is doing good. How is America actually doing?

« It is more of the same – recovering but doing so in a gradual fashion that falls short of “escape velocity.” While the US continues to economically outperform most other advanced economies, it is yet to fully recover the foregone income from the Great Recession. It is a situation that is also putting pressure on future growth potential».

The ECB raised slightly the forecast for GDP growth this year from +1,4% to +1,6% but left unchanged the estimate for 2017 while lowered that for 2018 (from +1,8% to 1,7%). Draghi read this improvement as the result of the ECB’s stimulus. Do you agree and are you happy with that figures?

«I agree with President Mario Draghi when he stated at Thursday’s press conference that the additional set of policy measures announced by the ECB in March played an important role in minimizing the risk of a worrisome Eurozone deflationary growth impulse following the January-February instability in global financial markets. I also feel that, outside periods of financial volatility, the ECB can continue to have a beneficial impact – albeit insufficient – on growth and inflation. But, without the support of other policies, its influence will remain modest; and it is not without risk given how deeply the ECB has already ventured into unconventional policy terrain».

In June the ECB will raise its bonds purchase from 60 to 80 billion euros monthly, and will start to buy corporate bonds. In addition it will hold a new auction for cheap loans. Will these additional measure spur a stronger growth in the Euro zone in the second part of 2016?

«There is unlikely to be a meaningful and sustained pick up in Eurozone growth unless the ECB’s measures are part of a more comprehensive policy response. Indeed, as stated by President Draghi, growth requires the implementation of structural reforms, including stepped up public investment in infrastructure, and more “growth friendly” fiscal policy stances. Absent that, growth will not only remain tepid but will also be vulnerable to non-economic shocks, be it the increasingly fluid domestic political conditions in some countries or the possibility of a Brexit».

In the press conference, after the ECB policy meeting on Thursday, Mr. Draghi repeated his calls for national government to cut red tapes that hinders hiring and starting a business, and spend more on investments. What is really holding off private and public investments?

«While the precise answer varies from country to country, there are some common elements. Four stand out in particular and are worth noting. First. through a rather unbalanced mix of fiscal policy within the Eurozone, the “will” to spend has ended up being excessively decoupled from the “wallet.” As such, Europe suffers from a deficiency of aggregate demand. Second, with the exception of Germany’s actions a decade ago, the Eurozone has lagged in implementing productivity enhancing measures. With this lack of structural reforms, the traditional engines of growth are not only sputtering but also require massive monetary stimulus. Third, governments have been slow to address pockets of excessive over-indebtedness that crush the debtor, both directly (through unsustainable debt servicing) and indirectly (by discouraging new inflows of capital). Greece is a case in point. Fourth, progress has lagged in completing the Eurozone’s economic and financial architecture, including in completing the banking union, agreeing on a common vision for fiscal integration, and showing greater resolve in maintaining and deepening political unity. The incomplete regional architecture has, in turn, has amplified the headwinds that come from insufficient policy coordination at the global level».

The ECB raised its outlook for inflation (from 0,1% to 0,2%) this year, while it sees it at 1,3% in 2017 and at 1,6% in 2018, though under the ECB target of just under 2%. Are these realistic forecasts? What else can be done to raise inflation without creating dangerous distortions?

«The revisions are actually quite minor, particularly given the fluid world in which Europe operates in, be it economic, financial or political. If the ECB were to end up missing its inflation targets, and this is an IF rather than a prediction, it is more likely to be to the downside».

One restrain for inflation to pick up is the oil price. What do you expect about energy prices?

« I think that oil prices will trade mostly, albeit not necessarily exclusively, in the $45-55 range for the remainder of the year, with an average of around $50. In maintaining its recent price rally, oil will be supported by three factors: a considerable amount of supply destruction, most of which has already occurred; some pickup in demand; and traders getting more comfortable with pricing dynamics that no longer rely on OPEC – and, in particular, Saudi Arabia – as a swing producer».

Low interest rates are here to stay says Mr. Draghi, who also left unchanged the negative rates on banks deposits with the ECB. How long can ​a zero and negative interest rates monetary policy be sustained in the long term and what are the collateral damages for the economy?

« It depends which part of the yield curve you are talking about. Very low interest rates can certainly be sustained for a long time at the short end where the ECB policy rates basically determines the interest rate on short dated instruments. The more one ventures out the yield curve, the greater the ECB influence interacts with economic factors and those coming from the rest of the world. When thinking of the long-term consequences of negative rates, it is critical to remember that important segments of modern economies were not built for such a world. As such, negative rates eat away at the institutional stability and efficiency of the system. This is most visible when it comes to the provision of longer-term financial services. From life insurance to retirement pensions, there will be mounting pressures on the existing architecture. And since you cannot replace something with nothing, individuals will be less able to save for the long-term, thereby gradually increasing their anxiety, lowering consumption and constituting yet another headwind to a full and timely economic recovery».

What are the political consequences of negative rates?

«As the case of Japan illustrates, negative interest rates tend to cause a lot of popular dis-satisfaction that results in greater political pressures on the central bank. The risk is an erosion in something that is very important for the well-functioning of market-based systems – that is, the political autonomy of central banks. Now the ECB is nowhere near where its counterpart in Japan has ended up. Specifically, the Bank of Japan is very close, if hasn’t already crossed the line that separates effective monetary actions from ineffective and potentially counter-productive ones. The ECB is a distance from that, and shouldn’t get too close to the line. Meanwhile, the Fed is trying to continue with its pivot away from unconventional policies, albeit a very measured and gradual one. Having terminated its program of large-scale asset purchases (or QE), it is on the verge of increasing interest rates again».

Who pays the highest price: banks and financial institutions or savers and pensioners?

«At the end of the day, it is savers, pensioners and consumers of long dated financial services such as life insurance».

The ECB is not willing accept Greek bonds as collateral yet, making things tougher for Greek banks. Should we read this decision as a lack of confidence in Greece progress? Will Europe ever cut the Greek debt or shall we wait after the German election in the fall of 2017?

«The ECB appears to be following the IMF in hesitating to again increase its financial exposure to Greece, and understandably so. After all, both are monetary institutions rather than fiscal ones. As such, they would like to see more of the burden being shouldered by national governments and the Commission. Europe must agree to debt relief for Greece if the country is to stand any chance of generating high inclusive growth, and do so in a sustained fashion. I cannot think of a realistic state of the world in which Greece can grow robustly without more meaningful debt relief. Indeed, even with debt relief, Greece would need to do a lot in terms of structural reforms if the country is to break out of this tragic period of economic contraction, worsening inequality, rising poverty, and financial instability».

Despite Greece, Brexit is the biggest risk today in Europe. Draghi wished that Britain stay in the EU but said they are ready for any result of the Brexit referendum. Are you afraid of the Brexit referendum? If Britons vote for leaving the EU, what will be the reaction on the financial markets? And the political consequences for Europe?

«A vote for Brexit in the June 23rd referendum bu British citizens would probably cause global financial volatility. The extent and duration would depend on how quickly an alternative arrangement, such as association agreement, could be placed on the table for discussion. Ironically, over the longer term, a Brexit could end up resolving a recurrent issue that has bothered Europe for quite a while. The UK thinks of the EU as a super free trade area. It’s a destination. Not so for the other large EU countries, including France and Germany. For them, the EU is part of an “ever closer union” that has economic, social, and political dimensions. It is therefore a means to something much, much larger. This constitutes a fundamental difference in vision for the EU. And it is one that is yet to be resolved despite decades of UK membership of the EU».